Diversification

Diversification is a risk management strategy to hedge against risk. To protect from risky investments, investors diversify their portfolios. Not everyone has well diversified portfolios. Professor Grace mentioned in class that the state of Georgia does not allow itself to be sued because it is well and perfectly diversified. This statement was made in a sarcastic tone I might add. The majority of people do not have well diversified portfolios, which refutes one of the assumptions of the Capital Asset Pricing Model. Most people have all their money invested in one large asset, such as their home. However, some businesses and some rare people with sound financial and RMI knowledge can have well diversified portfolios. We watched a video from the Morningstar website about proper diversification. The advice was to invest in about 15 securities. You invest in some risky and some stable to neutralize your risk and maximize your returns.

Some people also diversify more with an active management strategy. They are constantly trading securities when risks increase and decrease. However, I have learned that a passive strategy is more efficient. You would think, why would you sit aside and do nothing to encourage your investments? I have learned that an active strategy is difficult and more expensive. I do not have the time to sit around and actively watch my stock and trade it at anytime. Also, it has been found that passive gain is no less than the average active gain once you account for the large number of transaction costs with each extra trade. The passive managers can get a free ride on the active managers. Diversification and managing your securities is beneficial to your investments. If you feel you do not know enough information about investing or your finances, Morningstar is a helpful website with videos about tips and the current financial crisis.

http://www.morningstar.com/Cover/Tools.html